Test bank and solution manual of taxtation (1)

The three types of tax law sources include statutory authority issued by Congress e.g., the Internal Revenue Code, committee reports, judicial authority i.e., rulings by the U.S.. Suprem

Chapter 2 Tax Compliance, the IRS, and Tax Authorities SOLUTIONS MANUAL

or holiday, the extended due date will be the 1st day after October 15th that

is not a Saturday, Sunday, or holiday

(3) [LO1] Agua Linda, Inc., is a calendar-year corporation What is the original due date for the corporate tax return? What happens if the original due date falls on a Saturday?

The original due date for Agua Linda, Inc.’s corporate tax return is March 15th If the 15th falls on a Saturday, Sunday, or holiday, the due date will be the 1st day after March 15th that is not a Saturday, Sunday, or holiday In this example, Agua Linda, Inc.’s due date is March 17th (i.e., the Monday after Saturday the 15th)

(4) [LO2] Approximately what percentage of tax returns does the IRS audit? What are the implications of this number for the IRS’s strategy in selecting returns for audit?

Currently, less than 2 percent of all tax returns are audited The IRS must

be strategic in selecting returns for audit in an effort to promote the highest level of voluntary taxpayer compliance

(5) [LO2] Explain the difference between the DIF system and the National Research Program? How do they relate to each other?

The DIF system is basically a scoring system that assigns a score to each tax return that represents the probability that the tax liability on the return has been underreported (i.e., a higher score, a higher likelihood of

underreporting) The IRS derives the weights assigned to specific tax return attributes from historical IRS audit adjustment data from the National Research Program (NRP)

The NRP analyzes randomly selected returns to ensure that the DIF scorings are representative of the population of tax returns The DIF system then uses these (undisclosed) weights to score each tax return based on the tax return’s characteristics Returns with higher DIF scores are then reviewed

to determine if an audit is the best course of action

(6) [LO2] Describe the differences between the three types of audits in terms of their scope and taxpayer type

The three types of IRS audits consist of correspondence, office, and field examinations Correspondence examinations are the most common These audits (as the name suggests) are conducted by mail and generally are limited

to one or two items on the taxpayer’s return Among the three types of audits, correspondence audits are generally the most narrow in scope and least complex

Office examinations are the second most common audit As the name

suggests, the IRS conducts these audits at the local IRS office These audits are typically broader in scope and more complex than correspondence

examinations Small businesses, taxpayers operating sole proprietorships, and middle to high-income individual taxpayers are likely candidates for office examinations In these examinations, the taxpayer receives a notice that identifies the items subject to audit, requests substantiation for these items as necessary, and notifies the taxpayer of the date, time, and location of the exam Taxpayers may attend the examination alone, or simply let their tax adviser or attorney attend on the taxpayer’s behalf

Field examinations are the least common audit The IRS conducts these audits at the taxpayer’s office (i.e., place of business), or the location where the taxpayer’s books, records and source documents are maintained Field examinations are generally the broadest in scope and most complex of the three audit types They can last many months to multiple years and

generally are limited to business returns and the most complex individual returns

(7) [LO2] Simon just received a 30-day letter from the IRS indicating a proposed assessment Does he have to pay the additional tax? What are his options?

Simon does not have to pay the additional tax at this time The 30-day letter

instructs the taxpayer that he or she has 30 days (1) to request a conference with an appeals officer, who is independent (resides in a separate IRS

division) from the examining agent or (2) to agree to the proposed

adjustment If the taxpayer chooses to go to the appeals conference and reaches an agreement with the IRS at the appeals conference, the taxpayer can then sign the Form 870 If the taxpayer and IRS do not agree on the proposed adjustment at the appeals conference, or the taxpayer chooses not

to request an appeals conference, the IRS will then send the taxpayer a day letter (statutory notice of deficiency)

90-(8) [LO2] Compare and contrast the three trial-level courts

The U.S District Court is the only court that provides for a jury trial; the U.S Tax Court is the only court that allows tax cases to be heard before the taxpayer pays the disputed liability and the only court with a small claims division (hearing claims involving disputed liabilities of $50,000 or less); the U.S Tax Court judges are tax experts, whereas the U.S District Court and U.S Court of Federal Claims judges are generalists Both the U.S Tax Court and local U.S District Court cases appeal to the specific circuit court based on the taxpayer’s residence In contrast, all U.S Court of Federal Claims cases appeal to the U.S Circuit Court of Appeals for the Federal Circuit

(9) [LO3] Compare and contrast the three types of tax law sources and give examples

of each

The three types of tax law sources include statutory authority issued by Congress (e.g., the Internal Revenue Code, committee reports), judicial authority (i.e., rulings by the U.S District Court, U.S Tax Court, U.S Court

of Federal Claims, U.S Circuit Court of Appeals, or U.S Supreme Court), and administrative authority (e.g., regulations, revenue rulings, and revenue procedures) In addition to being issued by different groups, the format and purposes of each of these authorities are different Whereas statutory

authorities are tax laws enacted by Congress, judicial and administrative authorities generally interpret enacted tax laws

(10) [LO3] The U.S Constitution is the highest tax authority but provides very little

in the way of tax laws What are the next highest tax authorities beneath the U.S Constitution?

The Internal Revenue Code of 1986 and Supreme Court decisions represent the highest tax authority beneath the U.S Constitution However, the

Supreme Court does not establish law, but instead, simply interprets and applies the Code (and other authorities)

(11) [LO3] Jackie has just opened her Code for the first time She looks at the table

of contents and wonders why the Code is organized the way it is She questions whether it makes sense to try and understand the Code’s organization What are some reasons why understanding the organization of the Internal Revenue Code may prove useful?

One must understand the organization of a code section (i.e., into

subsections, paragraphs, subparagraphs, and clauses) to be able to cite the respective law correctly (e.g., IRC Sec 162(b)(2)) Many provisions in the Code apply only to specific parts of the Code If one does not understand what laws are encompassed in the chapter, it would be very difficult to

interpret the code section and determine its applicability to a research

question Finally, the Code has been arranged such that, in general, similar code sections are grouped together Understanding this organization allows the researcher to be much more efficient in locating relevant code sections

(12) [LO3] Laura Li, a U.S resident, works for three months this summer in Hong Kong What type of tax authority may be especially useful in determining the tax consequences of her foreign income?

The tax treaty between the U.S and Hong Kong

(13) [LO3] What are the basic differences between regulations, revenue rulings, and private letter rulings?

Regulations are the Treasury Department’s official interpretation of the Internal Revenue Code and have the highest authoritative weight among regulations, revenue rulings, and private letter rulings Regulations are issued in three different forms: proposed, temporary, and final In addition

to being issued in three different forms, regulations also serve three basic purposes: interpretative, procedural, and legislative Unlike regulations, revenue rulings address the specific application of the Code and regulations

to a specific factual situation Thus, while revenue rulings have less

authoritative weight, they provide a much more detailed interpretation of the Code as it applies to a specific transaction and fact pattern Letter rulings are less authoritative but more specific than revenue rulings and regulations Letter rulings generally may not be used as precedent by taxpayers

However, they may be cited as authority to avoid the substantial

understatement of tax penalty under IRC Sec 6662 imposed on taxpayers and related tax practitioner penalty under IRC Sec 6694 Private letter rulings represent the IRS’s application of the Code and other tax authorities

to a specific transaction and taxpayer Private letter rulings are issued in response to a taxpayer request and are common for proposed transactions with potentially large tax implications

(14) [LO3] Under what circumstances would the IRS issue an acquiescence? A nonacquiescence? An action on decision?

Except for Supreme Court cases, whenever the IRS loses, it may issue an acquiescence or nonacquiescence as guidance for how the IRS intends to respond to the loss Although an acquiescence indicates that the IRS has decided to “follow” the court’s adverse ruling in the future, it does not mean that the IRS agrees with the court’s ruling Instead, it simply means that the IRS will no longer litigate this issue A nonacquiescence has the exact

opposite implications A nonacquiescence alerts taxpayers that the IRS plans

to continue to litigate this issue Finally, the IRS also issues actions on

decisions, which explain the background reasoning behind an IRS

acquiescence or nonacquiescence

(15) [LO3] Carlos has located a regulation that appears to answer his tax research question He is concerned because the regulation is a temporary regulation Evaluate the authoritative weight of this type of regulation Should he feel more

or less confident in his answer if the regulation was a proposed regulation?

Temporary regulations, as the name suggests, have a limited life (three years for regulations issued after November 20, 1988) Nonetheless, during their

“life,” they carry the same authoritative weight as final regulations Thus, Carlos should be confident in his answer Proposed regulations are, as the name suggests, “proposed,” and thus do not carry the same authoritative weight as temporary or final regulations Carlos should feel less confident in his answer if it was based on a proposed regulation

(16) [LO3] Tyrone recently read a regulation that Congress specifically requested the IRS to issue What type of regulation is this? How does this regulation’s

authoritative weight compare to other regulations?

Legislative regulation Legislative regulations are more rare and are issued when Congress specifically directs the Treasury Department to issue

regulations to address an issue in an area of law In these instances, the Treasury is actually writing the law instead of interpreting the Code

Because legislative regulations actually represent the tax law instead of an interpretation, legislative regulations generally have been viewed to have more authoritative weight than interpretative and procedural regulations

However, in Mayo Foundation for Medical Education & Research v U.S., 131

S.Ct 704 (2011), the Supreme Court held (subject to specific conditions) that all Treasury regulations warrant deference

(17) [LO3] In researching a tax question, you find only one authority (a trial-level court opinion) that is directly on point Which court would you least prefer to have heard this case and why?

The U.S District Court because these decisions are often considered less authoritative and are likely rendered by a district court outside of the

taxpayer’s jurisdiction (versus the U.S Tax Court or U.S Court of Federal Claims which have jurisdiction over all taxpayers regardless of their

residence) U.S District Court decisions are often considered to have the lowest authoritative weight because the U.S District Court hears a much broader spectrum of issues compared to the U.S Tax Court or U.S Court of Federal Claims Thus, U.S District Court judges are considered generalists relative to U.S Tax Court or U.S Court of Federal Claims judges

(18) [LO3] What is stare decisis and how does it relate to the Golsen rule?

Stare decisis means that a court will rule consistently with (a) its previous

rulings (i.e., unless they decide to overrule the decision) and (b) the rulings of higher courts with appellate jurisdiction (i.e., the courts their cases are

appealed to) The doctrine of stare decisis presents a special problem for the

tax court because it appeals to different circuits based on the taxpayer’s

residence To implement the doctrine of stare decisis, the tax court applies

the Golsen rule The Golsen rule simply means that the tax court will abide

by the circuit court’s rulings that has appellate jurisdiction for a case The implication of the Golsen rule is that the tax court may issue conflicting opinions in different circuits

(19) [LO4] Mason was shocked to learn that the current Code is the Internal Revenue Code of 1986 He thought that U.S tax laws change more frequently What is wrong with Mason’s perception?

Congress enacts tax legislation virtually every year that changes the Code

1986 is simply the last major overhaul of the Internal Revenue Code All enacted changes are incorporated into the Internal Revenue Code of 1986

(20) [LO4] Describe in general the process by which new tax legislation is enacted

As required by the US Constitution (Article 1, Section 7), "All bills for

raising revenue shall originate in the House of Representatives.” The Senate may propose tax legislation, but the first to formally consider a bill will be the House, typically within its Ways and Means Committee After the

committee debates the proposed legislation and drafts a bill, the bill is sent to the House of Representatives for debate and ultimately a vote (either yea or nay without modification) If the bill is approved, it becomes an act and is sent to the Senate, which refers the act to the Senate Finance Committee Not to be outdone by the House, the Senate Finance Committee typically amends the act during its deliberations After the revised act passes the Senate Finance Committee, the act is sent to the Senate for debate and vote Unlike the process in the House of Representatives, senators may modify the

proposed legislation during their debate

If the Senate passes the act, both the House and Senate versions of the

legislation are sent to the Joint Conference Committee, which consists of members of the House Ways and Means Committee and the Senate Finance Committee During the Joint Conference Committee deliberations,

committee members debate the two versions of the proposed legislation Possible outcomes for any specific provision in the proposed legislation

include adoption of the Senate version, House version, or some compromise version of the two acts Likewise, it is possible that the Joint Conference Committee will simply choose to eliminate specific provisions from the

proposed legislation or fail to reach a compromise on the proposed

legislation, thereby terminating the legislation After the Joint Conference Committee approves the act, the revised legislation is sent to the House and Senate for vote If approved by both the House and Senate, the act is sent to the president for his or her signature If the president signs the act, it

becomes law and is incorporated into the Internal Revenue Code of 1986 (i.e.,

Title 26 of the U.S Code, which contains all codified laws of the US) If the

president vetoes the legislation, Congress may override the veto with a thirds positive vote in both the House of Representatives and Senate

two-(21) [LO4] What are the three committees that debate proposed tax legislation? What documents do these committees generate, and how might they be used?

The House Ways and Means Committee, Senate Finance Committee, and Joint Conference Committee each produce a committee report that explains the current tax law, proposed change in the law, and justification for the change These committee reports are considered “statutory” sources of the tax law and may be very useful in interpreting tax law changes and

understanding Congressional intent This is especially important after new legislation has been enacted because, with the exception of the Code, there will be very little authority interpreting the new law (i.e., no judicial or

administrative authorities because of the time it takes for the new law to be litigated or for the IRS to issue interpretative guidance – e.g., regulations, etc.)

(22) [LO4] The president recently vetoed a tax act passed by the House and Senate

Is the tax act dead? If not, what will it take for the act to be passed?

Congress may override the presidential veto with a two-thirds positive vote

in the House of Representatives and Senate

(23) [LO5] What are the five basic parts of an internal research memo?

The memo has five basic parts: (1) facts, (2) issues, (3) authority list, (4) conclusion, and (5) analysis

(24) [LO5] What is the difference between primary and secondary authorities? Explain the role of each authority type in conducting tax research

Primary authorities are official sources of the tax law generated by the

legislative branch, judicial branch, or executive/administrative branch Secondary authorities are unofficial tax authorities that basically interpret and explain the primary authorities Secondary authorities may be very helpful in understanding a tax issue, but they hold little weight in a tax

dispute (hence, the term unofficial tax authorities) Thus, tax advisers should always be careful to verify their understanding of tax law by examining primary authority directly and never cite secondary authority in a tax

research memo

(25) [LO5] Jorge is puzzled that the IRS and his CPA could legitimately reach

different conclusions on a tax issue Why does this happen?

The tax law is not always clear – i.e., the Code does not specifically address the tax consequences of each transaction type or every possible variation of a particular transaction and thus, the application of the tax law is subject to debate and differing interpretations by the IRS, courts, CPAs, taxpayers, etc

(26) [LO5] What is the difference between open and closed facts? How is this distinction important in conducting tax research?

Open facts are those that have not yet occurred (e.g., the facts associated with

a proposed transaction) Closed facts are those that have already occurred (i.e., facts that have already transpired) The distinction between open and closed facts is important because open facts can be altered, and thus are flexible Different facts may result in very different tax consequences Open facts allow the taxpayer to arrange a transaction to achieve the most

(28) [LO5] Amber is a tax expert, whereas Rob is a tax novice Explain how their process in identifying tax issues may differ

A CPA’s ability to identify issues is largely a function of his or her tax

expertise A tax expert in a particular area will typically be able to identify quickly the specific tax issues that relate to transactions in that area A novice, on the other hand, would likely identify broader issues first and then more specific issues as he researched the relevant tax law

(29) [LO5] Discuss the basic differences between annotated and topical tax services How are these services used in tax research?

Annotated tax services are arranged by code section – i.e., for each code section, an annotated service includes the code section, a listing of the code section history, copies of congressional committee reports that explain

changes to the code section, a copy of all the regulations issued for the

specific code section, the service’s unofficial explanation of the code section, and brief summaries (called annotations) of relevant court cases, revenue rulings, revenue procedures, letter rulings, etc that address issues specific to the code section

Topical tax services are arranged by topic (e.g., taxable forms of income, exempt income, trade or business expenses, etc.) For each topic, the services identify tax issues that relate to each topic, and then explain and cite (i.e., reference) authorities relevant to the issue (code sections, regulations, court cases, revenue rulings, etc.) Beginning tax researchers often prefer topical services, as they generally are easier to read

tax-An expert would probably go directly to the relevant portions of an

annotated or topical service A novice may conduct a keyword search in the service, use the tax service’s topical index, or browse the tax service to

identify the relevant portions of the service

(30) [LO5] In constructing a keyword search, what should the keyword search

a break

(32) [LO5] Nola is a tax novice and has a fairly simple tax question Besides tax services, what are some sources that she can use to answer her question?

Tax publishers, such as CCH and RIA, produce quick reference tax guides (e.g., the CCH Master Tax Guide or the RIA Tax Handbook) that may be used to answer basic tax questions

(33) [LO5] Armando identifies a tax research question as being a question of fact What types of authorities should he attempt to locate in his research?

If you are researching a question of fact, it is important for the researcher to understand which facts determine the answer In this type of question, Armando should focus his efforts understanding how various facts impact the research answer and identifying authorities with fact patterns similar to his client’s fact pattern

(34) [LO5] How are citators used in tax research?

Citators are used to review the history of a case (i.e., was it subsequently appealed and overturned?) and to identify subsequent cases that cite the case (i.e., either favorably, which strengthens the case, or unfavorably, which weakens the case) Citators can also be used to check the status of revenue rulings, revenue procedures, and other IRS pronouncements

(35) [LO5] What is the general rule for how many authorities a research memo should discuss?

Enough to provide a clear understanding of the issue and interpretation of the law It’s important to consider authorities that may support and

authorities that may go against your desired conclusion to reach an accurate assessment of the strength of your conclusion

(36) [LO6] Identify some of the sources for tax professional standards What are the potential ramifications of failing to comply with these standards?

Some examples include: the American Institute of CPAs (AICPA) Code of Professional Conduct, the AICPA Statements on Standards for Tax Services (SSTS), the IRS’s Circular 230, and statutes enacted by a CPA’s specific State Board of Accountancy Failure to comply with the standards could result in some rather adverse consequences for the tax professional (e.g., being admonished, suspended, barred from practicing before the IRS,

admonished, suspended, or expelled from the AICPA, suspension or

revocation of the CPA license, etc.)

(37) [LO6] Levi is recommending a tax return position to his client What standard must he meet to satisfy his professional standards? What is the source of this professional standard?

AICPA SSTS No 1 provides that a tax professional must comply with the

standards imposed by the applicable tax authority when recommending a tax return position or preparing or signing a tax return IRC Sec 6694 provides these standards for federal tax purposes

IRC Sec 6694 imposes a penalty on a tax practitioner for any position that is not supported by substantial authority A good tax professional evaluates whether supporting authority is substantial based upon the supporting and opposing authorities’ weight and relevance Substantial authority suggests the probability that the taxpayer’s position is sustained upon audit or

litigation is in the 35 to 40 percent range or above The tax practitioner can also avoid penalty under IRC Sec 6694 if the tax return position has at least

a reasonable basis (i.e., supported by one or more authorities) and the

position is disclosed on the taxpayer’s return

In 2011, Circular 230 was revised to reflect the tax practitioner standards in IRC Sec 6694 for when a tax practitioner generally may recommend a tax return position

(38) [LO6] What is Circular 230?

Circular 230 provides regulations governing tax practice and applies to all persons practicing before the IRS There are three parts of Circular 230: Subpart A describes who may practice before the IRS (e.g., CPAs, attorneys, enrolled agents) and what practicing before the IRS means (tax return

preparation, representing clients before the IRS, etc.) Subpart B describes the duties and restrictions that apply to individuals governed by Circular

230 Included in Subpart B are provisions discussing the submission of records to the IRS, guidelines when a practitioner discovers a tax return error, restrictions on charging contingency fees, prohibition of sharing

employment with someone suspended from practicing before the IRS,

stringent rules relating to providing advice for tax shelters, and standards for when a practitioner can recommend a tax return position Subpart C

explains disciplinary proceedings for practitioners violating the Circular 230 provisions

In 2011, Circular 230 was revised to reflect the tax practitioner standards in IRC Sec 6694 for when a tax practitioner generally may recommend a tax return position

(39) [LO7] What are the basic differences between civil and criminal tax penalties?

Civil penalties are much more common, generally in the form of monetary penalties, and may be imposed when tax practitioners or taxpayers violate tax statutes without reasonable cause, as the result of negligence or